Update on Market Volatility

As noted here and here, the media is jumping on the decline in the Vix Index, a measure of fear in the market, as a major source of optimism. As we wrote back in April, people continue to intrepret the Vix Index incorrectly.

If the market goes up the Vix goes down, plot the two on a chart and you will see a very inverse correlation between the two items. Therefore, the Vix does not predict the future but reflects what is currently going on in the market.

The real key in April that hinted that perhaps the rally had more room to run was the fact that the Vix had fallen but not as much as expected in relation to the rally in the S&P. Now we have the opposite problem. The Vix has gone back to the levels of September of 2008. The S&P on the other hand is still below it's high for the year (943 on January 6th) and below it's high for the month (930 on May 8th).

This seems to point towards a bit too much complacency. In September of 2008 you had a 1250 S&P and 25 Vix. By October you had a 840 S&P and a Vix near 80. A falling Vix has not been a great buy signal but rather a by product of a rising market. The Vix gave a buy signal when it was at 80 and had doubled in only a few short weeks. That was a buy signal. A drop from 80 to 30? Not a buy signal.

The drop in the Vix currently is just a reflection of the 39% rally in the S&P from high to low over the past two months. Tread carefully...